As President Donald Trump steps into the Oval Office, a number of issues loom large, but one may stand head and shoulders above the pack: the United States' growing national debt.
Till debt do us part
According to USDebtClock.org, the national debt is rapidly closing in on $20 trillion, which works out to more than $61,300 for every man, woman, and child in the U.S. and nearly $167,000 for every taxpayer in the country. The fact that the national debt continues to grow shouldn't come as a shock. With the exception of a few years during the Bill Clinton presidency, all other presidents' budgets in recent memory have run in the red. Perhaps even scarier is the fact that since March 1962, Congress has approved lifting the debt ceiling a jaw-dropping 74 times.
On one hand, using debt isn't necessarily a bad thing. As President Trump, who referred to himself more than once on the campaign trail as the "King of Debt," has suggested, debt can be used as a tool to incite economic growth. If interest rates are attractively low, consumers can use debt to buy homes, businesses can borrow to expand their workforce and buy new equipment, and the federal government can borrow to kick-start infrastructure and defense projects that can boost GDP and create jobs.
On the other hand, too much of a good thing can be bad when we're talking about debt. Without restraint and an eventual plan to pay back what's borrowed, debt can be both burdensome and a growth inhibitor to a country. As the U.S. allows its national debt to grow, the burden and cost to service the net interest on that debt can grow as well. The more the federal government has to set aside to cover its net interest payments, presumably the less capital it has to spend on growth initiatives, such as education and infrastructure. It could also begin to tighten the belt around so-called entitlement programs like Social Security, Medicare, and Medicaid.
Here's what 75 years of net interest payments looks like
Over the past 75 years, the net interest paid by the federal government on our national debt has ballooned from $889 million in 1940 to an estimated $229.2 billion in 2015. Below you can see a 75-year history of just how quickly net interest payments have grown, based on data from the U.S. Office of Budget and Management (OBM).
One thing you'll note from the above chart is that the current amount the federal government is setting aside to service the national debt isn't a record high. The record was set back in 2008 when $252.8 billion was needed to cover net interest on the U.S. national debt. This roller coaster in net interest costs tends to be influenced by two key factors: fiscal and monetary policy.
Fiscal policy refers to the budgetary adjustments the federal government makes each year to control its spending levels and tax rates in order to influence the economy. Generally speaking, periods of weak economic growth or recession, as well as periods of war, can lead to increased spending, wider federal budget deficits, and the potential for an increase in net interest payments on the U.S. national debt.
Monetary policy describes the method by which the Federal Reserve Bank controls the money supply in the U.S. and influences interest rates. Just as consumers and businesses rejoice when interest rates are low, so does the U.S. government, to some extent. Lower interest rates mean lower interest expenses on our national debt. The federal funds target rate has been kept near a historic low for practically eight years, and it's a big reason why we've yet to surpass the 2008 record high for net interest payments in a year.
However, the Federal Reserve is in the midst of a somewhat new tightening policy. Over the past 13 months, the Fed has increased its benchmark interest rate by 25 basis points on two separate occasions. Increasing the federal funds target also means the interest paid on national debt rises, too.
The Office of Budget and Management also listed net interest payment estimates for years 2016 through 2020 based on its projections for a steady increase in interest rates in the years to come. Here's what the OBM's estimates look like when added to the 75-year chart of net interest payments:
Based on these estimates we can really see the expected impact of higher interest rates on what was a substantial increase in national debt during the Obama administration. Between 2015 and 2020, the percentage of annual federal spending being diverted to cover net interest payments on our national debt is expected to grow from 6.1% to 11.1%. Ouch!
Trump has a big task ahead
Long story short, Donald Trump has the difficult task of figuring out how to keep the U.S. economy rolling, while also devising a plan not to push the U.S. national debt higher. Based on multiple initial analyses of Trump's revised tax plan, there's a real possibility he follows in the footsteps of his predecessors and increases U.S. national debt levels while in office.
While Trump has offered a number of ways to save money in Washington, including reforming healthcare in America, his keynote legislation is likely going to be his individual and corporate income tax reforms. Here are the basic tenets of Trump's tax reforms:
- Individual income tax brackets would be reduced from the current seven tiers (ranging from 10% to 39.6%) to just three tiers (12%, 25%, and 33%).
- Nearly all itemized deductions, save for the mortgage interest deduction and charitable giving deduction, would be eliminated, and standard deductions would be more than doubled.
- Corporate income tax rates would fall to 35% from 15%.
- U.S. multinationals would be given a tax repatriation holiday rate of 10% to encourage them to bring back some of the nearly $2.5 trillion in cash being held overseas.
According to an analysis by the Tax Foundation, Trump's tax plan could increase GDP by 6.9% to 8.2% over the next decade, but it's also expected to reduce federal income by $2.6 trillion to $3.9 trillion over the same time span on a dynamic basis (i.e., factoring in the positive impacts of Trump's proposals on the U.S. economy).
Unfortunately, U.S. national debt may continue to climb for the foreseeable future, which is potentially bad news for growth initiatives and entitlement programs.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.